Demographics, New Assumptions Drive Commercial Real Estate

A turning point has been reached in the economy and both demographics and the assumptions that traditionally drove the commercial real estate industry are shifting.

But while economists speaking on a panel at the Strategic Real Estate Conference held in New York this week agreed that this is a time of incredible change, they also see opportunity.

Panel moderator Gunnar Branson, the Chicago-based president and CEO of the National Association of Real Estate Investment Managers, began the discussion by noting that people’s living space has switched from the office to the home since the 1970s. Back then, he explained, office space averaged 500 to 700 sq. ft. per person, while residential space was 250 to 300 sq. ft. per person. Today, the average office allows 200 sq. ft. per person. Meanwhile, residential space has risen to over 900 sq. ft. per person.

However, an even more impactful change is occurring through the use of technology. “The most important piece of real estate is in our back pockets,” Branson said, referring to smart phones. Every 18 months since 1965, the capacity of computer chips has doubled, decreasing the need for collections of books and publications, records and DVDs, electronic equipment and paper files. This is driving the office market: Every new law firm lease is for one-third less space than its predecessor.

Technology and the echo boomers—those born between 1982 and 1995 and began reaching college age in 2000, who number approximately 80 million—are also changing the multifamily market. “They don’t have a lot of stuff and they can live and work comfortably with one-third less space than we could,” said Branson. Apartments of 300 sq. ft. or less is an emerging trend.

What’s more, he added, echo boomers are less likely to drive. In the 1990s, people in their 20s accounted for 20 percent of the miles driven in the U.S., Branson noted. Today, they account for less than 14 percent. “They like to live in cities, and if they don’t live in New York they like to live in cities that behave like New York—like Austin or Denver,” Branson said.

Since the very essence of commercial real estate is “simply a factor of production of the local economy…obviously you want to be where smart people are doing smart things—like New York, San Francisco, Silicon Valley, and it’s always changing,” said Mike J. Acton, managing director of AEW Research, a division of AEW Capital Management L.P., institutional investment advisor based in Boston.

Acton said that although the baby boom generation began turning 65 last year, he sees their children exerting a strong influence on real estate for a much longer period. “We’ve got another 20-year window with the baby boomers,” he said. However, the echo boomers will be around much longer, “and they want different things.”

Acton sees “a huge demand” for 300-sq.-ft. apartments. Currently, he said, Boston is working to add up to 1,500 more small units in the Seaport District, and AEW is in the process of building them in Santa Monica, Calif. “There is a waiting list for them—we can’t build them fast enough,” he said. “[Echo boomers] don’t want a lot of space. They want Santa Monica. They go home at night and sleep. They don’t cook.”

David Wyss, former chief economist at Standard & Poor's and now a visiting fellow at Brown University, warned that care must be taken with demographics.

“People aren’t behaving the way they did five years ago now,” Wyss said. Assumptions made, for instance, about golf course and condominium properties as being safe investments turned out incorrect. “Older people are not turning into migrating snowbirds anymore,” he said. Many can’t afford to move or prefer to remain near their extended families.

David J. Lynn, the former managing director and head of investment strategy and research at Clarion Partners, said he sees real estate as being driven by both the older and younger populations.

The baby boomers are more educated than past older generations, he said, and with their value-add, they will retire later. “Before, people did wear out at 65,” he said. “Now, with more intelligent service work, people will work into their 70s and 80s. They won’t go to retirement communities the way they were.”

Noting that 75 percent of America’s population currently lives in urban areas, Acton said gateway cities draw people with their “true downtowns,” but smaller cities are also developing “little nodes of tech hipness” like Denver’s LoDo.

For the younger generation, being in a secondary or tertiary market is “a scary proposition” without that, Lynn said. “If they lose their job, there are no others, so they need to be in a city like New York or San Francisco for networking.”

And, like young workers, capital tends to “go where it feels safest,” Acton added. But while he sees institutional capital gradually spreading beyond core markets, “we’re not going back to 2006 and 2007 when Nashville and San Francisco real estate was the same price.”

The core markets are relative, said Lynn. Right now, for example, the U.S. is a safe bet for foreign investors, which is helping fuel growth in the larger markets. The cost of capital is low, he said, so it makes sense to invest in core real estate at the bottom of the NOI cycle.

The conference was held on June 7 and produced by National Real Estate Investor, REP., Trusts & Estates and the newly launched WealthManagement.com in New York City. More than 150 wealth management and commercial real estate professionals attended the event.